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Margin lenders have a list of approved securities, stocks and funds against which they will lend. The Loan to Valuation Ration (LVR) is the amount you can borrow as a percentage of the value of the security. A loan of $50,000 secured by a portfolio valued at $50,000 would be 50% LVR. Margin loans are interest only loans and borrowers are able to capitalise interest up to the LVR. So an investor who borrows at a LVR of 50% on a portfolio with a 70% limit can allow interest to capitalise until the loan reaches the maximum LVR.
The interest on margin loans can generally be claimed as a tax deduction. Investors can prepay interest and bring forward tax deductions by paying 12 months' interest in advance. By making an interest payment in June for the next financial year, borrowers may then claim a deduction for the whole amount against taxable income in the current financial year.
Margin Calls
If a loan exceeds the maximum LVR by only a few percentage points, usually 5%-10%, lenders considers to be in a buffer zone. Borrowers face a margin call When the maximum LVR and buffer have been breached. When faced with a margin call, borrowers must restore the balance by topping up your account with cash or additional securities or sell securites. If you fail to meet a margin call, the lender has the right to sell your securities.
Risk Management
There are a number of ways to minimise the risk of gearing:
| Borrow conservatively |
Do not gear up to the maximum level allowed by the lender |
| Do not over-commit |
Borrow what you can comfortably repay |
| Diversification |
Don't rely on a concentrated portfolio |
| Long-term investing |
Think long-term to give your investments sufficient time to generate enough capital growth |
| Insurance |
Obtain salary or income protection insurance to protect against selling your investments at a possible loss if you or your spouse become seriously ill or disabled |
| Fixed loans |
Fix your loan to protect your cash flow in case interest rates rise |
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| Entry Fees | Entry fees are optional. Are you paying entry fees on existing managed funds? more info
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